The impact of collateral-based monetary policy on green financing cost: an analysis of the People's Bank of China’s approach

This paper examines the effects of the collateral-based monetary policy, implemented by the People’s Bank of China, on green financing costs. Employing a Difference-in-Differences (DID) method to examine credit spreads of financial bond in primary and secondary markets from 2017 to 2019, our findings highlight a significant decrease of 26 basis points (bps) in the financing costs of green financial bonds in the primary market, with a 12-bps decline in the secondary market post-policy. Our study underscores the crucial role of implicit credit enhancement provided by the People’s Bank of China's collateral endorsement. Interestingly, the liquidity provision mechanism, where investors pay premiums to secure liquidity support, does not find empirical backing in the specific context of China's bond market. These findings illuminate the effectiveness of collateral-based monetary policies in reducing green financing costs, offering valuable insights for using collateral strategies to green monetary policies.Collateral-based policies’ success in reducing green financing costs suggests a strategic avenue for supporting green monetary policy goals.Implicit credit enhancement serves as a crucial mechanism driving this cost reduction.The People’s Bank of China's experience exemplifies the robustness of such policies without requiring strict collateral scarcity, highlighting broad policy applicability.Collateral-based monetary policy could drive the ‘green premium’, broadening green bond appeal beyond just environmentally-focused investors.